SME Stocks Offer Unmatched Growth Potential

SME Stocks Offer Unmatched Growth Potential

SME investing has rewarded risk-takers in the past and as the family of SME stocks increases every year, the prospects of SME investing gets even better. Ganesh Vaybase tracks the SME stocks' performance and highlights the top performers in the SME space while also discussing why SME investing is in vogue

SME (small medium enterprises) investing is not new to market participants now that both the platforms i.e. BSE SME and NSE Emerge platforms are quite vibrant and regularly getting increasingly new businesses (SME) listed on the platform. Traditionally, the micro-caps and small-caps have been the favourite hunting ground for retail investors. SME investing has not come to that level yet in terms of popularity yet it is slowly making some ground for itself. Steadily, more and more SME stocks are getting listed on the SME platform and several SME stocks are getting migrated to the main board, which is a sign of success for those involved in the whole process, including the stock exchanges, companies, investors and the regulators.

SME stocks are nano-cap stocks and can help investors tap some abnormal growth opportunities in the equity markets. However, before investing in SME stocks it is vital for investors to understand the role that SMEs play in the economy. SMEs in India are crucial to the economy as the sector produces a diverse range of products and services while contributing to value-addition across sectors in India. Experts call SMEs the backbone of India that drives the overall economic growth of the country. SMEs contribute substantially to the employment generation in the country too. In fact, the SME sector in India is one of the biggest beneficiaries of various initiatives such as ‘Make in India’, ‘Start-Up India’, ‘Mudra Yojana’ and ‘Skill India’.

SMEs are viewed as important by the government because the sector is considered to be the catalyst to socio-economic transformation in India. The service sector in SMEs has a higher share in India’s GDP compared to the manufacturing sector. Healthy contribution to total exports is one of the reasons why the SME sector is considered vital from India’s point of view. SME investing provides investors with a unique opportunity to tap the unmatched growth potential provided by the sector. The BSE SME and NSE Emerge platforms help investors participate in the growth story of the SME sector in India.

SEBI first propagated in 2008 , the framework for setting up of SME exchanges. A major step , however, was made by the Prime Minister's Task Force in January 2010 on Micro, Small and Medium Enterprises , which recommended setting up of SME exchanges to promote inflows of equity capital in this sector. Later on in 2012 , the BSE SME and NSE Emerge platforms were established . 

SME Indices

It will excite investors to know that we now have a Nifty SME Emerge index that captures the performance of select liquid SME stocks listed on the NSE Emerge platform. The constituents of the NSE SME Emerge are selected based on their free float market capitalisation. The index is reconstituted on a quarterly basis and can be used by market participants to gauge the performance of the SME stocks in India.

The eligible scrips that are the constituents of the Nifty SME Emerge index are liquid stocks and hence can be perused by investors for fundamentals. SMEs stocks are usually neglected because of lack of liquidity in the counters. The index has a base date of December 1, 2016 and a base value of 1,000. As per the website of NSE India, the eligibility criteria for the stocks to be included in the index are:

The stock should be listed on NSE Emerge platform.
The stocks should have traded for a minimum 25 per cent of trading days subject to a minimum of 10 trading days during the previous three months at the time of quarterly review.
Constituents are weighed based on free float market capitalisation.

Nifty Emerge index has delivered 7.85 per cent returns on an annualised basis since its inception while on a QTD basis the index is up by 9.40 per cent. On an YTD basis the index is down by 2.70 per cent and on a one year basis the index is down by 2.46 per cent. The dividend yield for the index is 0.37 per cent while beta for the index with Nifty is 0.19. The correlation with Nifty is 0.54 while the PE for the index is 18.45. One of the most interesting aspects for any long-term investor when it comes to investing in SMEs is its low correlation with the Nifty. This low correlation suggests the value-addition that can happen by including SME stocks in the portfolio. The BSE SME IPO index has 17 constituents and has delivered nearly 10 per cent returns on an annualised basis in the last five years. The median market-cap for the constituents of BSE SME IPO index is Rs 14.60 crore. 

Migration to Main Board 

One of the biggest incentives for the SME stocks to get listed on the SME platform is the chance to migrate to the main board after the initial listing on the SME platform. Post this migration to the main board, the SME stocks are bound get more liquid and more exposed to institutional and retail investors in general. Thus, one can expect wider participation in the SME stocks once they migrate to the main board. The process for migration is not complicated. The issues of SME stocks may as an option migrate to the main board of the same recognised stock exchange as per certain criteria and compliance with eligibility requirement of the stock exchange. 

Following are the eligibility criteria for migration to the main board:
The SME-listed company willing to migrate to the main board should have been listed on the SME platform for at least a year and the number of shareholders should be minimum 200 while making an application.
The company should have a profitability or net worth track record of at least three years or have 75 per cent of its capital held by a qualified institutional buyer (QIB).
The minimum promoters’ contribution shall be 20 per cent which will be locked in for three years.

SME IPOs 

The SME Capital Markets have helped many companies in expanding their business. The SME IPO listings have increased since the introduction in 2012 and today the BSE SME platform has over 350 companies listed on it and the NSE Emerge platform has over 200 companies listed on it. With minimal cost for listing and relaxed listing norms compared to the main board, the SME platforms are ideal for companies who wish to raise capital to meet their growth requirements. Increase in the number of SME stocks on exchange and good results is encouraging more investors to invest in the SME segment. Of the stocks listed in 2020, Janus Corporation was the top performing SME IPO with gain of 113.6 per cent. For 2019, 218, 2017 it were Jonjua Overseas, Manorama Industries, Pure Giftcarat with gains of 318 per cent, 336.17 per cent, 373.85 per cent respectively.

Conclusion

SME listing not only help the company but also benefits the shareholders. The listing provides an exit route to private equity investors as well as facilitates liquidity to the ESOP holding employees. Once a company gears up for a listing on SME platform the corporate governance standards tend to improve, which results in image enhancement for these small companies. Such improvement brings in sustainability and fosters higher valuation for the listing company. The year 2020 has been one of the toughest years for the SME sector in India. Yet the SME IPO flows have been decent considering the situation on the ground. Various government announcements supporting the sector should augur well for SME investors. Also, the waiver of interest on interest on moratorium may further provide relief to SME players. SME investing is all about a bottom-up approach to investing. Investors need to identify stocks that are liquid enough and have high corporate governance standards. One prudent approach that SME investors can adopt is to invest in only those SME stocks that are the constituents of the SME indices i.e. either Nifty SME Emerge or BSE SME IPO index. This will ensure that the SME stocks are sufficiently liquid and have passed the essential screening of corporate governance by the respective stock exchanges. While both the parameters do not guarantee that the stocks will outperform, investors can focus on relatively highquality SME stocks while making investment decisions. Another profitable way to participate in the SME stocks can be to wait for the stock to migrate to the main board. Generally, the stock should do well once it migrates to the main board but it is not necessary that the stock will start inching up just because it has done such a migration. However, the stocks will be scanned by different types of investors (institutional and retail) once they migrate to the main board and hence there will be wider participation by investors and the probability of SME stocks improving their performance will become better. The basics of investments and portfolio management rules should apply to SME investing as well. It is important that investors construct a portfolio of SME stocks rather than bank on one or two SME stocks that show promise. SME investing is for seasoned investors who understand the tricks of fundamental investing. The ticket size of investing is also very high and hence most retail participants may not be able to participate in SME investing activity till the time the stocks migrate to the main board. 

Methodology for picking Top 50 SMEs 

To come up with a list of ranking of top 50 SME companies, we compiled data for all the SME companies listed on BSE based on four crucial parameters. The first includes market capitalisation. The second and third parameters obtained from the Profit & Loss Account include Sales and Net Profit. Lastly, we factored in the returns earned by investors by computing the 1-year simple returns delivered by the stocks. Each parameter was then ranked by awarding it a carefully determined weightage based on its significance. This was followed by a consolidated ranking to arrive at the list of Top 50 SME companies. All the raw financial data is sourced from Ace Equity.

To download the Full List of SME Stocks Click Here 

 

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